We’ve seen that building a lifelong passive income through share investing is very possible. However, tax costs can take a massive bite out of the amount we have to live on.

In the UK, both dividends and capital gains are taxed. And the amount we have to pay to HMRC is getting larger.

Here’s how I’m hoping to avoid big bills and maximise my passive income.

Rising tax bills

Dividend allowances have fallen sharply in recent years. Investors can now only enjoy £500 in dividends before they have to start paying tax. That’s down from £1,000 last year, £2,000 the year before that, and £5,000 just seven years ago.

And following last week’s Budget, the rate of capital gains tax (CGT) investors must pay has also soared.

For basic-rate taxpayers, the rate has leapt from 10% to 18%. Meanwhile, the rate has increased to 20% to 24% for higher-rate taxpayers. The annual CGT allowance has been frozen at £3,000.

And the tax grabs could continue, as the government seeks to raise much-needed revenues.

ISAs and SIPPs

This is why I invest using only tax-efficient products. With my Self-Invested Personal Pension (SIPP) and Stocks & Shares Individual Savings Account (ISA), I don’t need to pay a penny in capital gains tax or dividend tax.

The amount I can invest in each has an annual limit. This is £20,000 for an ISA, and typically a sum equivalent to my annual income (up to £60,000) for my SIPP.

With my SIPP, I also get tax relief on any contributions I make. This is 20% for basic-rate taxpayers, and 40% and 45% respectively for higher-rate and additional-rate taxpayers respectively.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Over time, using one of these tax-efficient products could save me a fortune. Let’s say that Steve, a higher-rate taxpayer, invested £20,000 a year for 10 years. Over this period, he achieved an average annual return of 8%, giving him a gain of £89,525.

After applying CGT allowances, £59,525 would be subject to capital gains tax. If the CGT rate remained at 24% over the period, he’d pay a total of £14,285 in tax.

However, the cost of these tax bills to Steve would likely be higher. By having less capital in his portfolio, his ability to generate compound gains would be diminished.

A top ETF

With ISAs and SIPPs, investors can also handily invest in a wide range of shares, funds and trusts. One investment that I’ve recently been adding to my own pension is the iShares Edge MSCI USA Quality Factor UCITS ETF (LSE:IUQA).

This exchange-traded fund invests in a selection of stocks “that have historically experienced strong and stable earnings“. It holds a total of 124 companies, in fact, like Nvidia, Apple and Visa, which in turn helps me to spread risk.

Past performance is no guarantee of future returns. And lower growth in the US could impact what I make. But the fund has provided an impressive average annual return of 14.7% since 2016.

If this continues, a £300 monthly investment here in my ISA could turn into £1,113,157 after 25 years. And because I wouldn’t have to pay tax, this would give me a £44,526 annual passive income if I drew down 4% each year.